Thursday, December 16, 2010

Joy Global's Growth is Dependent On China Housing Market

China Construction holds the key to JoyGlobal Prospects?

Mining equipment company Joy Global gave results yesterday  and not only were they impressive, but the outlook statement was very positive too...

mining companies are realizing strong demand and prices, with the expectation of significant increases in demand during the next 3 to 5 years. As a result, they are making major increases in their capital expenditures for mine expansions. Mining companies have announced capital expenditures that are up 30 to 35 percent this year, and are approaching the levels of 2008. In addition, announced capital expenditures for 2011 are expected to rise another 15 to 20 percent. everything looks rosy according to Joy Global's earnings release. With Joy Global and the likes of UK's Fenner, you have upside from a few strategic profit drivers.

Firstly, there is the resolution of economic growth and industrial capacity utilisation in the developed industrialised nations. This strengthens demand for commodities such as copper and coal.

Secondly, there is the secular trend towards shifting energy production towards using coal and away from oil. Not only is this a response to geopolitical risk with oil supplies but also it is reflective of the global shift towards manufacturing in the Far East. Coal is the major commodity that China is rich in.

Thirdly, there is the significant investment being planned in infrastructural projects within emerging markets. Many of these projects are pre-planned and committed and are essential for the long term growth of these countries.

Finally, there is the marginal demand from residential housing and construction in the World.

China's Construction Market is the Marginal Demand Driver

Of all of these profit drivers, I would view the key marginal  (housing and construction) as being the most important. My view is that Europe's banking sector will face more Sovereign Debt issues next year and this will cause some disruption to their recovery in the first half. Turning to the US, frankly, I don't think the US is in a position yet to see strong increases in new construction activity...

...and this is mainly due to the ongoing high vacancy rates

and also a result of a large number of foreclosed homes still waiting to come onto the marketplace.

So much depends upon whether China's property and construction markets are in a bubble or not?

China Property Market. An Asset Price Bubble?

Poetic symmetry seems to demand a bubble here. Japan had it, the US had it, the UK had it in the 90's and even Sweden had it in the 90's. Furthermore, with China you have a situation whereby currency manipulation (they are buying US Dollars and selling RMB) is flooding their internal markets with RMB which could be causing a local asset bubble. Throw in the extra stimulus efforts made by the Communist regime and you have all the ingredients for a bubble.

However, the tricky part here is to try and quantify the nature of the mass urbanisation movement within China. Jim Chanos claims that 60% of China's GDP is due to Fixed Asset Investment whilst only 5% is due to exports. You can see the importance of this kind of growth on global steel production here...

source: worldsteel

...and with so much of other emerging markets (Russia, Brazil) dependent on commodity exports to China, the knock on effect of a slump in China's property market is significant.

China Housing Vacancy Rates?

The problem that Chanos and others have is that there are no official figures for China's vacancy rates. However, we do know that according to the National Bureau of Statistics of China (NBSC)  Investment in Real Estate Development Enterprises is currently growing at a yearly rate of 34.2%

I do not think this is sustainable and also note that the Chinese are trying to deal with overheating in commodity prices and real estate, by successively raising banks reserve requirements. They may engineer a 'soft landing'. Who is to know? I'm sympathetic to Chanos' arguments on China and housing but the exact timing is hard to predict. Nevertheless, I do not think that now is the time to be meaningfully overt in this sector.


Fortune Magazine "Chanos vs. China" (accessed Dec 2010)

NBSC "Investment Completed and Growth of Real Estate Development Enterprises"  (accessed Dec 2010)

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